The rules of Australia’s energy markets continue to be redrawn after the South Australian pricing regulator on Tuesday cut its calculation of wholesale energy costs and recommended that retail electricity prices be cut by 8.1 per cent.

The draft decision by the Energy Services Commission of South Australia (ESCOSA) may only directly impact the customers of AGL Energy on standing contracts in that state – but it’s likely to have a profound ripple effect on the energy industry in Australia.

The decision recognises that the game is changing because of the growing impact of renewables and falling demand. It also recognises that the industry’s power over the regulators is waning fast, and its ability to gold plate its assets – be they networks or generation plant – is rapidly declining.

ESCOSA – against the wishes of the conventional energy industry – has redrawn the way that prices should be estimated. It was a bit of a no-brainer, because ESCOSA had previously allowed the wholesale price allowance to reflect what the utilities estimated as the long run marginal cost of energy. But it turned out that this calculation was up to three times the actual cost – ESCOSA had allowed electricity companies to pass on a rate of $90 per MWh, although the cost of the electricity on the open market had dropped to as low as $30 per MWh.

ESCOSA now proposes a calculation that better reflects the cost of purchasing energy on the wholesale market, and all the hedging that takes place as well. The result is that – even after taking into account the carbon price and the cost of renewable energy schemes – the wholesale component of the electricity bill will come down sharply – and translate into a cut in retail bills. It suggests that these cost reductions be reflected in the bills of all customers, not just those on standing charges.

This ruling should not come as a surprise, except to those who insist that wind and solar does nothing but add to the cost of electricity. For much of the past year, wholesale electricity prices have been trading at or around their lowest levels since the creation of the National Electricity market more than a decade ago, yet retail electricity bills have soared, thanks to billions of dollars in network spending which is now being heavily scrutinized.

But apart from a few instances, such as IPART’s decision in NSW where wholesale costs had a minor depressing effect in its recommended retail electricity estimations – consumers have not benefited from this fall.

South Australia, however, is a special case because the actual cost of buying electricity on the wholesale market has been impacted more directly by the “merit order effect” – the downward pressure on wholesale prices caused when wind and solar farms (which have zero cost fuels) are constructed and produce energy.

South Australia has the highest penetration of wind in Australia – it accounted for around 26 per cent of energy supply in the year to the end of July, overtaking coal and trailing only gas. It also has the highest penetration of solar PV in the country – 2.4 per cent of its electricity last year was sourced from rooftop panels – and this has made a major contribution to reduced demand on the NEM, and in turn to lower electricity costs. Indeed, AEMO has cut its energy demand forecasts for the state by 10 per cent, mostly due to a 7 per cent reduction from the solar-powered residential sector, where one in 5 houses has a rooftop solar installation.

The influence of wind and solar is expected to increase in coming years. AEMO predicts that solar PV will make up 3.4 per cent of energy demand in the state in the current year – rivaling the penetration in Germany, which has had a dramatic impact on wholesale prices. By 2020, it says, the solar PV could account for 6.4 per cent of demand. It estimates that one third of solar PV installed in the state is producing at times of peak demand.

This, in turn, has led to the state’s two coal-fired generators, to be put in mothballs because the ageing plants can no longer make money with wholesale prices falling so low. The two plants that once provided 30 per cent of the state’s energy have now been shunted out of the market by a combination of wind and solar – apparently more expensive – and lower demand. This is the future faced by the conventional energy industry everywhere – in the eastern states, in the US and in Europe.

This table below explains what happened in South Australia. In 2010, ESCOSA allowed a wholesale price component of $93.93, plus estimates from line losses, various fees and the cost of the the two components of the renewable energy target (large scale – essentially wind – and small scale – essentially rooftop solar).

The second column shows the increase when the impact of the carbon price is added in. But the third column reflects the new estimates, based on a formula the reflects the cost of buying energy on the market (not simply the spot price, because utilities need to hedge and lock in long term contracts), with an additional $8/MWh of “headroom” – a profit margin that retailers can play with to “compete” with each other, plus line losses and (slightly lower) estimates of the cost of the RET.

Note: The REC Agents Association underlined the impact of solar PV on wholesale prices in a research note that also points out that estimates of the impact of the cost of the small scale component of the renewable energy target have been grossly over-estimated, particularly by those seeking to have the target reshaped.

The RAA says the combination of rooftop solar and solar hot water has caused a 1.2 per cent fall in power consumption across the NEM – around half of the reduction noted in the market. It estimates this can be quantified at $20 per MWh, or 2 cents per kWh, and the contribution of rooftop solar to reducing power consumption is expected to more than double by 2015 – with further impact on wholesale electricity prices.

And it notes, the cost of the small scale scheme will continue to fall. From 2014, once the multiplier is phased out, it will account for less than one per cent of retail electricity prices. It also notes that the real cost of the scheme is well below the $40 a certificate that retailers are allowed to pass throught to their customers. The market price of these certificates is close to $30.

It will also destroy competition and entrench flat tariffs leading to no investment in innovation and energy efficiency. Not to mention the impact of limiting renewable investment by making investors worried about further regulatory intervention. If you can find anyone who has skin in the game on renewables (actual investment, not a lobby group) who thinks regulating retail prices is a good outcome, please let us all know. Otherwise, please don’t perpetuate this nonsense.

Kevin Meyerson

@Greg

I don’t follow your logic at all. Lower prices are the result of more competition in the market via renewables. The article clearly explains this fact along with a significant amount of supporting evidence.

Greg: When we insist on privatizing monopolies we need price regulation to prevent price rip-offs.

Greg

Again, find me a renewable energy company with significant skin in the game that supports regulating retail prices.

J

John D is correct. Monopolised industries are classified in economics as “failed markets” and are characterised by a few dominant players who extract monopoly rents from customers. It is not possible to apply “free market” competition rules to failed markets. This should be obvious. It is like trying to referee a game of soccer using the AFL rule book.

So privatising players in a failed market is mostly pointless and will probably result in future re-nationalisation as governments pour funds into keeping these companies afloat by falsely creating ‘market’ based margins.

The NBN is a classic case of a quasi re-nationalisation of the comms network after a brief experiment in privatising a failed market… failed.

Savings and loan banking is another area where privatisation is showing no benefits to competition. Why, the big four operate in a failed monopolistic market while claiming it is competitive (they think we are stupid).

Australia is simply too small a population with too much landmass for certain markets to work. The government at the turn of last century understood this, so its time we relearned what is obvious.

Greg

Funny, not one renewable player has jumped in saying this is a good outcome. Supporters of renewables would be wise to take note – these issues aren’t simplistic – there is no “us” and “them”. If you want renewables deployed, you need good policy across the supply chain.

Claire

Greg is quite right. Regulating a retail electricity price below the long run cost of generating and distributing that electricity is madness – it is ensuring that one or more parties along the supply chain must incur a loss.
Who in their right mind would invest their capital in a sector where a government agency is in the business of mandating losses? Get ready for some perverse outcomes from this short sighted policy.

So Claire, are you saying that if the wholesale price of electricity in South Australia falls, which it has, retail prices shouldn’t fall?

Claire

Ronald – If the cost of providing the electricity falls, then I am all for the regulated tariff reflecting this – for example, if there was a technology breakthrough which meant electricity could be generated more cheaply (which sadly solar and wind are not yet).

My issue is that the regulator is setting an effective price cap that is lower than the cost of providing the service, undermining the long term sustainability of the sector. You might think this is fine if you are sure there will never need to be any more investment in conventional generation in this country, but I for one would not gamble with the provision of such an essential utility.

There is plenty of competition in SA and several retailers offer significant discounts off the regulated tariff, so consumers don’t have to look far to get a better deal. Retailers are free to offer whatever discounts they want, and the low wholesale price is one reason they are able to do so at the moment. Why is it even necessary to regulate electricity prices when there is so much competition?

Claire, wind power and solar have reduced the wholesale price of electricity in South Australia.

Claire

Ronald – But the cost of generating 1 MWh of solar or wind is still more expensive than 1 MWh of conventional coal or gas, where most of our electricity still comes from.

As Greg mentions, a low wholesale energy price is not even a good thing for renewables developers – if the wholesale price plus the REC price is still lower than the long run cost of wind, then who is going to put up the capital to build new wind farms? Why would any retailer write a PPA with a wind farm developer if they are not able to recover the cost from the retail market?

Greg

Again, the silence is amazing. For all of these contributors (Claire excluded), where is the renewable energy company that supports your views. Do you not think it bizarre that you espouse views that the very companies wishing to build the things you supposedly support don’t share?